Success in Franchising

When I tell someone that my business law practice focuses on franchising, I will at times get a blank stare. This is where I explain that franchising is a concept where a person licenses out their brand and business system to another person in order for that person to operate a similar business under the same name. If I am still getting a deer-in-the-headlights look, I will say, you know, like McDonald’s. Once the golden arches are mentioned everyone understands.

 

However, I was recently reading an online article from Entrepreneur Magazine about the top franchises[1]. The surprise I took away from this article was the fact that Subway outranked McDonalds on the list of America’s top 10 franchises and the top 10 international franchises.

 

I don’t know the exact ingredients that Subway has combined in order to make their franchise even more successful than the most well known franchise in the world. If I were to guess, I would not bank it on the popularity of Jared as a spokesperson, $5 footlongs, or the innovative and newest sandwich. Instead, I would guess that, in some way, Subway’s franchisees are making more money than McDonald’s franchisees.

 

Whenever I meet with a new startup franchisor, the number one thing I like to emphasize is that a successful franchise brand is one in which the franchisees are successful. There are other issues to consider for success, but a franchise system in which the franchisees have the ability to make money will grow. Successful franchisees will tell others about the franchise and franchise sellers and brokers will feel comfortable pushing the franchise brand over other brands.

 

Some other factors that go into the success of a franchise business include: having a teachable system in place; providing the proper amount of support to the franchisees; excellent training; creative branding; and good marketing. All of these things will help the franchise system grow. But when you really focus on these additional items, they all boil down to the same goal: helping the franchisee turn a profit.

 

So the next time you want to brainstorm about expanding your franchise business, first look to your system and see how you can help your franchisees increase their profits. This will help you increase the number of franchises in your system. Maybe one day your system will be even more recognizable than the golden arches.

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[1] http://www.entrepreneur.com/slideshow/222422

Trade Secrets In Your Business

When it comes to trade secret, most of the public would be able to point to the Coca-Cola or the KFC secret recipes. It is common for many businesses to hold secret and confidential information that is not known to the public. In order for this information to rise to the level of a trade secret a two-prong test must be met: the information must be kept secret through reasonable efforts, and an economic value must be derived from the secret information. If both these prongs are met then you are likely dealing with a trade secret.

Trade secrets are valuable intellectual property because they never expire (so long as the information is kept secret) and unlike a patent, no disclosure to the public is required. In the United States most states, and the District of Columbia, have adopted the Uniform Trade Secrets Act (the “Act”), or have adopted a version of the Act (Massachusetts, New York and Texas have not adopted the Act but have their own trade secrets acts).

What is a Trade Secret?

Most states adopting the Act define a trade secret as “information, including a formula, pattern, compilation, program, device, method, technique, or process, that:

     (a) derives independent economic value, actual or potential, from not being generally known to, and not being readily ascertainable by proper means by, other persons who can obtain economic value from its disclosure or use; and
     (b) is the subject of efforts that are reasonable under the circumstances to maintain its secrecy.” (See Utah Code Ann. § 13-24-2(4)).

Ultimately courts will look at six general criteria when determining if information constitutes a trade secret:

1.   Is the information claimed to be trade secret known outside of the business?

2.   Is the information readily known and available to most employees in the business?

3.   Is the information labeled as “confidential” or “trade secret” and are steps or measures taken to maintain the secrecy of the information? (also with this, courts will look at if employees are told certain information is protected trade secret).

4.   The amount of money spent by the business in developing the trade secret.

5.   The economic value derived from maintaining the information as secret.

6.   The difficulty or ease of discovering the secret.

A trade secret must be identified with reasonable particularity. In other words, claiming all documents created in a business are trade secret is not sufficient. Businesses should take steps to identify what they believe is trade secret and determine why it is trade secret. If it meets the definition and would pass the court’s scrutiny, then reasonable efforts should be immediately taken to protect the information as a trade secret.

Remedies

One of the tricks in trade secret protection and litigation is that the mere taking of information does not necessarily rise to the level of trade secret misappropriation. Another difficulty is if an employee or person is given access to the allegedly secret information, but is not told it is secret and given instructions on how to protect the secret, the information may have lost its trade secret status.

If you are able to show that the misappropriator used the secret information, and they had actual or constructive knowledge that the information was secret, then the courts can grant injunctive relief and can grant damages and attorney’s fees in some states.

Ultimately the burden rests on the business to prove trade secret protection. 

If you have a business that allows its employees to have access to confidential and trade secret information, you should develop a clear policy that prohibits the information from being stored on personal computers, taken from the office without prior authorization, and that requires any copies made to be immediately returned to the employer. These and other steps can minimize the exposure of a trade secret inadvertently (or purposefully) leaving the business and in turn lowering the amount of protection afforded to that information. 

Franchisor Duties: Protect the Brand

Recently the Quebec Superior Court ruled that Dunkin’ Donuts’ master franchisee had failed to protect and enhance the Dunkin’ Donuts brand in Quebec in violation of its contractual obligations under the franchise agreement with its Quebec franchisees. The Superior Court noted that this was one of the franchisor’s few duties under the agreement and its failure to do so led to 200 store closures.


This is a chilling reminder to all franchisors of their duty to protect the brand. In the Dunkin’ Donuts’ case, the franchisor claimed that it was competition from another brand that hurt their system. But the court showed that the franchisees had alerted Dunkin’ Donuts of the competition back in 1996 and asked for some sort of plan to respond to the effect the new competitor was having on their sales. Unfortunately, Dunkin’ Donuts did nothing to try to counter the negative effect this new competition was having on its franchisees.


This is just one example of how a franchisor can fail to protect the brand. The franchisor needs to be constantly aware of its brand and protecting that brand in the market. Some of the areas the franchisor needs to monitor to protect its brand are as follows:

• Make sure that franchisees are using the brand only as directed by the franchise agreement and operations manual. Franchisees that do not follow the system and operate under the brand name can effectively hurt other franchisees.

• Monitor the use of the trademark to ensure that others are not using the marks or marks that are significantly similar to the franchisor’s mark. This can dilute the marks, cause confusion in the market and ultimately hurt the value of the brand.

• Monitor competition with the brand and come up with ways to counteract the effects of competition on the brand. (This is the Dunkin’ Donuts example.)

• Review the brand to ensure that the brand is current for the marketplace. This may mean updating the brand so that it appears fresh and continues to draw old and new customers.

Vicarious Liability and Franchisors

A rising concern for franchisors is being found vicariously liable for the acts of its franchisees. Previously, when a franchisor was sued, the franchisors could cite the fact that the franchisee’s business was “independently owned and operated” from the franchisor’s business to be removed from the lawsuit during summary judgment and escape being dragged into trial to determine liability. However, in the last 20 years courts have looked to the controls of the franchisor over the franchisee’s business to deny summary judgment and allow a jury to find the franchisor vicariously liable.

This leads the franchisor with the unclear position of trying to determine how best to keep its system uniform and protect its trademarks through controls and yet not cross over this hazy line to be found vicariously liable.

The nature of the franchise business is a long term relationship that needs uniformity and flexibility. To meet these objectives, most franchisors exercise controls through an operations manual. The courts not only look at the franchise agreement to determine liability, but they also look to the operations manual. This is a very broad test of control. The concern about such a broad control test is that almost every franchisor has very significant controls through their operations manual in order to maintain uniformity and protect their marks.

Recently, some courts have been more specific about the controls they look at to determine vicarious liability. The controls must be related to the matter that was the cause of the injury. Just because the franchisor gives guidance and controls over a majority of the franchisee’s business, that is not enough, unless the franchisor had the right to control the particular activity giving rise to the claim. Even if the franchisor gives direction and guidance regarding the direct activity that caused the injury, there may be some additional hope for the franchisor. In Ketterling v. Burger King Corporation the fact that Burger King’s operations manual specifically stated that the franchisor did not have control over the day to day operations of the franchisee made the court find that the franchisor could not be vicariously liable and allowed summary judgment.

When drafting an operations manual, the franchisor should consider the following:

1)         Does the control lead to an obvious potential vicarious liability claims? If so, consider the following question.

2)         Are the controls necessary for protecting the franchise system and trademarks? If not, the franchisor may not want to include such controls. If so, the franchisor should consider the following question.

3)         Does the operations manual clearly and concisely state that the franchisor does not control the day to day operations of the franchise business? If not, the franchisor should include this in the operations manual and in the franchise agreement.